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Recorded at CAPA Live March

CAPA Chairman’s Update: Environmental Sustainability

As aviation and travel continues what can only be described as a period of darkness, the industry that emerges will look vastly different than it did before the COVID-19 outbreak. The implications are wide-ranging and highly disruptive. As a continuation of CAPA’s Masterclass Series, CAPA – Centre for Aviation’s Chairman Emeritus Peter Harbison delivers a global big picture overview of our industry and where it will be in 2021.

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Transcript

Speaker 1:

Hello, and welcome to CAPA Live for March 2021, an interesting time, and a lot of expectation in the wind, I think.

I'm going to start today talking about the environment, because sustainability is obviously a key thing, even though our major focus is obviously on recovery of the aviation industry, but the two are going to have to go hand in glove and I've entitled this, finding a balance between survival of the world and survival of the aviation and travel industry.

Finding that balance is not an easy equation. One is an existential threat, and the other one is a threat to our existence, and we need to find that balance. One's very short term, the other one is short-term and long-term. The existential threat really is about travel ans tourism, which accounts for about one in 10 jobs or did in 2019, one in 10 jobs around the world, and one in five of every new jobs, according to the WTTC. And in a lot of cases, from Greece to the Pacific Islands, to you name it, are even more reliant on travel. And a large part of that traveling inevitably is by air, so the aviation system is inextricably linked to travel.

On the other hand, the existence threat, this quote from NASA, "Carbon dioxide from human activity is increasing more than 250 times faster than it did from natural sources after the last ice age," which is a good balance. And that graph is quite striking, the a vertical line in terms of carbon dioxide levels increasing.

When we did our 2020s outlook at the end of 2018, in airline leader, we were looking at the key issues that were going to be affecting the industry. Sorry, that was 2019, looking at the key issues for the 2020s. And top of the list inevitably was sustainability. There was a lot of noise at the time publicly, and there was a real recognition in the aviation industry that this was going to be a key issue. It wasn't just something we could public relations away, it was going to be a constraint on growth. And the important thing to remember as we go into a regrowth period is that that is not going to go away. It's still a critical part of the whole aviation equation.

The Airlines For America, A4A, recently put out some slides, just recapitulating the fact that the airline industry was unique as an industry globally and coming together a long time ago in agreeing something called CORSIA, the Carbon Offsetting and Reduction Scheme for International Aviation, CORSIA, which talks in terms of a carbon neutral growth in aviation, beginning in 2021. And the intention there is to reduce CO2 emissions by 50% by 2050, as compared with 2005 levels.

What does that mean? Well, in 2005, the airlines carried a total of 2.1 billion passengers. By 2019, passenger numbers had more than doubled to 4.6 billion and the growth dissipated very, very quickly in 2020, of course, so that today we're actually back at 2005 levels in terms of passenger numbers. It's a dramatic reduction obviously, and it's not going to stay there, hopefully. But equally importantly, the level of emissions is much, much lower today, probably 30%, thanks to the greater efficiency of aircraft engines, and in some cases, operating procedures. So we are getting somewhere, but once that growth starts rushing back, anything's possible.

The positive is that aviation emissions will be well below 2019 levels, still for some years to come. Long-haul international, for example, is going to be very slow to return. The estimates are that probably, this year at a maximum, 50% of long-haul, that is wide-body operations, will return. And those operations in 2019, long haul wide body operations, accounted for about 40% of total emissions. By taking half of that out of the equation, we're looking at just there alone, a 20% reduction in emissions, very significant amount.

Logically, what we're talking about therefore, because of the reduced amounts of travel and of flying, on the one hand, the pressure to reduce emissions in the short term will be relaxed. Or alternatively, and this is quite possibly the case, pressure will grow to keep emissions at the same level as they are now, that is to reset the base for growth. I think the outcome is probably likely to be a bit of both of those, but with a lot of tension on the second level.

Bill Gates just recently published a book called How to Avoid a Climate Disaster. And he said a lot of sensible things. It's not necessarily, in this argument, a good idea to have Bill Gates on your side, because he does get a lot of pushback from many, but he makes several relevant points in the aviation context, I think. First of all, there's not enough money, time, or political will to reconfigure the energy sector in 10 years. So trying to reach impossible goals, just doom the world to insufficient short-term gain. Also carbon emissions, and this is important from our transport perspective, carbon emissions are not going to get to zero simply by people flying or driving less. What's needed really, to change things significantly, is a holistic approach. It means zero carbon ways to produce electricity, to make things, to grow food, to keep our buildings cool or warm, and to move people and goods around the world.

Crucially, people need to change radically how they produce. And the worst climate offenders, and the things that need to change more, are steel, meat, and cement. Making steel and cement alone accounts for about 10% of all global emissions, and beef alone, for 4%. He didn't mention, but might have, that fashion also accounts for somewhere around 10%. These are all areas which can change quite dramatically at a personal level, we can make things different. But he says, according to Bill Gates, the focus needs to be on the radical changes needed to transportation, buildings, industry, culture, and politics. There is no single breakthrough, he says, that can solve all those things.

From an aviation point particularly, Microsoft has set an example with Alaska Airlines, for example. Bill Gates says, offsets not by planting trees, which is becoming a bit of an unknown and perhaps losing a bit of its reputability, but offset by buying sustainable aviation fuel. As he says, another example of using procurement to drive down green premiums involves the airline industry. Your company, and he's talking about companies like Microsoft, can offset the emissions from employees' travel by buying sustainable aviation fuel for the miles they fly. That creates demand for clean fuels, attracting more innovation in that area, and it makes travel related emissions a factor in your company's business decisions. So Microsoft and Alaska Airlines signed a deal like this for some of the routes they fly back in 2020, and that's because Microsoft uses Alaska Airlines quite widely.

So the core issues around addressing environmental sustainability, in the short term, emissions should not be a problem as air services will still be a shadow of their former selves until well into next year. But as that recovery occurs, the industry is going to have to make and be seen to be making some much bolder steps, both to produce new solutions and to show that progress has been made.

And governments, businesses, and investors will increasingly pressure the aviation industry to do that as I've talked about many times. In terms of the practical solutions, this is a picture of an Archer eVTOL, which can fly distance of up to 60 miles at speed of up to 150 miles an hour. But they're planning future models, which will travel faster and further and further. And that's going to revolutionize commuter travel, not long distance travel, but commuter travel, the last miles as it were.

Meanwhile, biofuels are still prohibitively expensive and supplies are inadequate and will never be sufficient totally to replace existing fuels. So E-fuels in that context of the longer term goal. All very, very difficult to achieve, but they need to be there as goals and they need to be worked towards. One of the key underlying issues here is that the focus for government should remain on how to reduce CO2 emissions rather than the sort of short-sighted and ineffective measures such as new taxes. They really don't achieve a lot. And then positively as part of President Biden's new US dollar two trillion climate plan East pledged to incentivize the creation of new sustainable fuels for aircraft. So that's a real step in the right direction, and it's far more productive and useful, I think, than imposing taxes. And hopefully other governments will be influenced by that as well.

Just one other thing about the market and what it's saying about recovery. It's always interesting to look at the share markets, so I'm going to go through quite a lot of airlines and this around the world. Ideally, you don't invest in airlines and I'll come back to that point later, because they're really not good investments, let's face it. But people do speculate in airlines. They trade in airlines. And as a consequence, what we, what we see with the share market and its trends here is really what the market is betting is going to happen. Doesn't mean they're right. But I think as we go around the world, we do see some interesting trends and I think it's useful therefore, to look.

So starting with North America, these are in each case, five year graphs of how the shares are performed over the last period from 2016, right through to just this last couple of weeks. Delta is trending upwards, very quite steeply in fact, from where it was just three or four months ago, understandably. But it's still well down on it's a peak price. Around about 45, $50 compared with $60 plus previously. United, not fairing quite so well, it's considerably below, it's roundabout $85, 85, $90 as it was just over a year ago down to about half of that now.

American also, has been on a steeper longer trend in fact, and it's well below its 2018 levels, but also, like the others starting to trend upwards as the market sees some hope around the corner. Spirit Airlines as an LCC is interesting in the context of the general full service versus low-cost carrier trend. It's moving back up fairly substantially, but it's still well down on its peak levels, which is perhaps a bit surprising and you'll see why I'm saying that in a moment.

Jet Blue is performing much better. It's getting back up close to its level of late 2019, early 2020. Again, for reasons that I'm seeing it positioned fairly well in the market. Southwest is the best passenger performer in this context, it's pretty much back to where it was just over a year ago, suggesting that it's well patronized and that investors have a lot of hope in its future. The standout among the passenger airlines of course, is Allegiant an unusual, if not unique model, which is benefited from its point-to-point operations and its real focus is a key thing on the leisure markets and they're the ones that are coming back first, which is why I'm a little bit surprised the Spirit isn't doing better because that focus on the lower yielding traffic is really what's counting.

So in fact, Allegiant is up about, what are we looking at? Probably about 30, 40% on where it was just over a year ago, remarkable in the circumstances. One is not so remarkable, but it's also dramatic is UPS. There's obviously money in parcels and that's obviously been something that we've all participated in over the last 12 months or so. UPS and to a slightly lesser extent, FedEx have done very, very well in this process.

This next line is interesting because what we're doing here is comparing not just the airline with its previous existence, but also with the standard and Standard and Poor's Index in the US. So while UPS looks really dramatically improved, it's still lagging behind the wider Standard and Poor's Index. And if we look at the other carriers like United and Delta, Alaska even, they're dramatically below where the Standard and Poor's are. So over the last five years, the S&P is up about by about 100%. It's almost doubled in that period. Whereas in most of the cases, the airlines are pretty much flat, back where they started in 2016.

Looking at Europe, quite a different picture for Ryanair. It's looking very strong, it's back to above where it was in year ago. And therefore, obviously the market is anticipating significant growth by Ryanair. It's interesting because as you can see from this slide, Ryanair is hardly flying at the moment. It's got almost all of its aircraft on the ground as the solid green line there shows. What is interesting is the dotted green line, which has Ryanair backup to pretty much its prior levels, it's 2019 levels by July this year. Then interestingly, and it's going to be very interesting to see what happens in the market is pretty much the sort of trajectory that most of the other airlines scheduling into their summer season schedules, which means that suddenly we're going to be back according to that, that schedules, which are very much 2019 levels, but quite patently are not going to be at the sort of levels that we saw back then in terms of passenger demand. So it's going to be an interesting period, the initial one.

As I suggested last month, people aren't going to be queuing up to provide their capacity. They're going to be jumping into the market very, very quickly and it's going to be to put it bluntly, a blood bath, with predominantly lower yielding traffic really driving the market and pushing fairs down almost inevitably. Wizz Air also in Europe, very, very strong well above its 2019 levels. And again, virtually without flying at the moment.

EasyJet's not doing so well, it's taking a much more conservative approach and is more of a hybrid, much more of a hybrid than a genuine LCC these days. And I guess it's paying the price in that respect. International Airline Group, bear in mind that the UK carriers have not been supported by the government other than the sort of generic support for employee salaries. But unlike say Lufthansa, which is actually plotting along the bottom, but again turning upwards a little bit, even despite very, very significant support from the German government. Air France, likewise is tipping up a bit, but again, with a lot of support from the French government. Obviously the moderation among the full service carriers in Europe is due to the fact that COVID is still very much less than under control in most of continental Europe.

And because of, who knows what, politics messing up, the vaccine process is not moving anywhere near as quickly as in the UK's. KLM has performed much better in these circumstances. A lot of freight in there. It has cut back fairly effectively on many of its routes, but it's also very much at the lower cost end, cost in terms of unit cost and of the full service market. So it's looking actually quite useful.

Turning to Asia Pacific. China, you'd expect China to be back where it was in 2019 because the market is performing, or because COVID is very much under control there, but it's not. It's well down. There's a lot of competition in market. Also, there is quite a lot of constraint on growth in the market. So obviously the shareholders are a little bit nervous in the Chinese market. Spring Airlines is performing considerably better.

In Korea, Korean Airlines is really way up performing very, very strongly, and that's because to some extent, the presumptive takeover of Asiana and its dominance in the market, but it still has a long way to go. Of course, it is a big freight carrier as well and it's benefited from that. The next two carriers, Cathay and Singapore Airlines, although they're trending up a little way, are down on previous, and that's because of course they have no domestic market and they rely entirely on a lot of the network traffic coming back. They have a way to go yet.

JAL, Japan Airlines also coming back. Looking quite good, despite the fact that Japan is suffering from a second wave and the government is a little bit cautious about growth there. Cebu LCC out of the Philippines is actually not performing very well. Again, it's because international markets are very difficult in the Asia Pacific region because of much greater conservatism that we see there.

If you have a substantial domestic market and you've got COVID under control, VietJet is a wonderful example of an airline that's actually made a profit for calendar year 2020, one of the very, very few who managed to do that, and they're looking pretty good now. But the domestic market is mostly where it's at with a lot of freight. As I mentioned last month, over 50% of their revenue has come from so-called ancillaries, which includes movement into the cargo market there.

Qantas really peaked at the end of 2020 when was anticipated that the domestic market was going to open up entirely. But then, and this is what I call a hiccup effect, suddenly state borders started to close again as one or two cases came back and state borders very rapidly closed. So it slumped again. But we're looking now at borders being open at the market, really starting to fire up, and Qantas could probably be even a little bit more optimistic as an investor, as a speculator anyway, in that market.

Latin America, Azul, Brazil is really suffering still, whatever it is, the continuing wave or the second or third wave or fourth wave in terms of COVID. I think, Azul, which has continued to operate pretty much at 50% and above is perhaps paying the price for that. The anticipation is not for a lot of growth in the short term. Aeromexico of course has had its problems, and despite the Mexican market really being fairly active still.

You can see that from Volaris. This is where we have a very strong LCC in that market and it's performing extremely well with a lot of anticipation that things will improve very quickly. LATAM, of course, has suffered dreadfully during this period and is still looking to find some new growth.

Africa. It's very hard to find airlines that do have a listing in the marketplace there outside of North Africa. But Kenya Airways is probably a fairly good indicator with that but thin blue line taking it right down to really fairly negligible levels. So how do we regrow the industry? Well, internationally, border relaxation is going to be depend very much on national health authorities being confident that they can open up the markets.

Because there are a lot of cases, this is from an IOTA graph, remaining high in most regions, it's aided by the arrival of new variants, new mutations in the market. It's made governments, health authorities, and even airlines, very cautious about growth. If the airlines are going to cease to burn cash, obviously the key to that is relaxing travel restrictions. IOTA's forecast is actually more pessimistic than it was back in December in terms of what the cash growth is likely to be this year. I'm sure you've seen already that up to almost $100 billion of additional cash burn in 2021 is anticipated if restrictions are only relaxed slowly.

On a global basis, that does look likely to be the case. In some markets, obviously things will be different, but probably in very few miles markets will rise to the sort of high expectations of some observers. IHME, which has been pretty accurate in its projections is still seeing another 100,000 deaths in America by mid-June, even despite the vaccinate. That's down considerably from what it was when President Trump was still running things with vaccinations. Obviously, the new administration is really rolling things out very, very quickly.

But even so, that's a very high level of death rates and is something which still continues to deter travelers and to make opening up of all the accoutrements of travel that much harder. As I mentioned before, Brazil is doing very, very badly and is the only country in the world, which is actually likely to suffer worse than the US.

I want to go back to something we said this time last year. I mean, we're looking at borders closing and the whole health issue. This was the crisis we seriously could not afford to waste is what we were saying back then. There's always some good to come out of a crisis. If you really look at things carefully, you can actually reset the direction of the industry. As we noted then, the glaring fact that's so often overlooked is that the airline industry was perpetually unprofitable even before COVID-19.

So in simple terms, most government industry supportive action that was occurring at that time and it's still occurring with, for example, the Biden administration pumping in another $14 billion into the airline industry to keep it going up until September. So in simple terms, we said, most government industry supportive action looks no further than trying to perpetuate what has been demonstrated over decades to be a failed model.

An interesting little a bit from Warren Buffett, back in 2002, and I'll quote from this. This appeared in Airline Leader just recently last year. Warren Buffett, "The airline business has been extraordinary. It's eaten up capital over the past century like almost no other business because people seem to keep coming back to it and putting fresh money in. You've got huge fixed costs. You've got strong labor unions and you've got commodity pricing. That is not a great recipe for success."

2016 Warren Buffett when taking a new stake in each of the biggest four airlines in the US was banking on them continuing to make substantial profits in the longterm, because, one, he said they benefit from market concentration. And two, there is concentration in their ownership with a small number of hedge funds and others holding strong equity positions in each of the major carriers, in other words, market dominance. So he invested deeply.

At that time we rather bravely boldly and perhaps in pertinently said, Warren Buffett's got it wrong again. This is in 2016. By 2020 at the latest, his US airline investments will all have started to unravel. And sure enough, in May last year he told shareholders that he had sold all of the company's airline stocks admitting he'd made a mistake. Now governments are not admitting that, looking backwards in the rear view mirror. The New York Times in the 19th of February this year just noted the fact that the four largest US airlines lost more than $31 billion last year. Industry overall is still shedding more than $115 million each day, according to A4A. These losses are even more stark when you consider the airlines have received $40 billion in federal grants to help pay employees and tens of billion of dollars more in low cost government loans. The problem is airlines these days cannot fly airplanes with enough people at high enough fares to break even. And then of course, as I mentioned, Congress has now voted an additional 14 billion to help the airlines pay their staff through till the end of the third quarter.

So how do waste a good crisis? Through COVID 19 we will have evolved from an unprofitable industry with an inadequate regulatory structure, to an unprofitable industry with an inadequate regulatory structure. And you have US dollars, 250 billion of additional debt propped up by governments. That's wasting a good crisis. So we're living a dream, but is it really any more than a dream? With large doses of government funds injections and support everything's going to return to normal soon. Don't think so. How long does long haul full service function with less than half of its business yields, which is going to be the case probably for two years and with a debt burden that exceeds historic industry profits, just to service that debt.

So when do we get back on the road again? Well, countries are slowly opening up, this is according to UNWTO recently, only 2% have no access restrictions. Although the positive is, and this is back to November so we don't have most recent numbers, but back in November at least 44% of countries were actually partially open, which involved in most cases tests and quarantine requirements, significant quarantine requirements. So they're not really open in those terms. Converting optimism to reality, a lot of optimism obviously around vaccinations and to some extent, the fact that governments have started to learn how to control things nationally, and also start to talk internationally between themselves. The current rate of vaccinations though, less than 20% of the world's population is expected to be inoculated this year, according to UBS. Developed nations, like the US and the UK will be vaccinated early and probably have the prospect of reopening once they get to herd immunity, that's a very, very big market of course. I say the US and UK specifically, because mainland continental Europe may take a little bit longer.

Again, that sort of bubble does leave the uncertainty of what I call third party mingling, that is if you've got bilateral parties in a bubble, each of them needs to accept any added third country origin travelers who are mingling with them until you've got total vaccination you can be certain that there's going to be no carriage of the COVID-19 back when they return. So in this context passports are becoming a key tool, I'll talk about it in a moment, but they are just tools. The vital precondition is multilateral government, health authority, consensus, and a commonality of approach. And that's a long way off it seems to me.

So passing through this traveled past profusion we've got, understandably a lot of organizations are anxious to establish a general platform and individual companies are actually looking to achieve market advance by adopting some form of recognizable evidence that a passenger has been vaccinated. And I've listed here, I'm not going to go through them, listed a number. Obviously the amount of travel paths is attempting to be the core, but in reality it seems to be vital that that travel path will also be able to embrace a whole host of others, whether it be airlines or whether it be companies who are establishing some form of path, digital, or otherwise. There needs to be cohesion there, there needs to be coherence. I don't think we're going to see one individual breakout like a VHS back in the old days, it's going have to be some sort of compendium of different systems.

So when we talk about bubbles, they do sound fun, but we've seen very much in Australia and New Zealand it's not easy. And I think it's a really good case because both countries have adopted a very similar suppression strategy. We have almost no cases at all. New Zealand just had three or four and had to shut down Auckland, pretty much. In Australia, we've had no cases for weeks now. So life is pretty much back to normal but opening up that bubble with New Zealand, which should be the easiest thing possible, we're near neighbors, we have a lot of social and commercial commonality, enormous VFR market. They should be ideal for a bilateral bubble, and it was expected to operate several months ago. But even with a modicum of government coordination, just between two governments who speak the same language, we play a lot of games with each other, it's been extremely difficult to get something which is acceptable to both sides, particularly given Australia as a number of states, which each has their own head in this argument as it were. So we've seen that this mix of politics and national self-interest make stable, reopening, highly complex. And I think it's important to look at that case study and just see how things can work in future.

Importantly, and I said this again last month, the vaccine is not a silver bullet and it can't be. We're going to continue to have this hiccup effect where uncertainty about variants and mutations, opening up, closing down again if things start to look bad and that's going to be done on a national basis, I think we've realized that that's an inevitable outcome of this horrible disease. And as I mentioned before most of the world won't be vaccinated this year or even next year.

So the real focus needs to be on to get travel going in a predictable way. The real focus needs to be on improving procedures for testing pre and post flight, the tracing context when cases occur and of course for coordinating national standards and policies. That's really where the silver bullet's going to have to be.

So in conclusion, the bottom line, when existential threat meets existence threat what is needed is lots of government and industry coordination because each of those is vital to our near and long-term future. And we're going to have to juggle them and live with them for many years to come. Thank you.

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